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ra(§\fffi1k IT (G) Opinions expressed in this newsletter clo not necessarilv reflect the views of the management of the Feeleral Reserve Bank of San Francisco, or of the Board of Covernors of the Federal Reserve System. of savings deposits and other non-transaction instruments, which yield about the same as N OWs but are not checkable. As a result, M-l B's growth rate has been inflated this year because it contains a coml Xlnent which it did not include in earlier years. Moreover, although funds transferred from savings to N OWs may be used to make payments, their owners probably will continue to treat them as savings rather than transaction accounts. This poses a problem for the Fed because it wishes to control the rate of growth of transaction balances. Therefore, the Fed has attempted to construct a statistical magnitude comparable to the earl ier M- 1 B series by adjusting the data to exclude balances shifted to newly opened N O W accounts in 1981 from sources other than demand deposits. However, it is difficult to obtain information on the proportion of new N OW accounts which are not truly transaction balances. The Fed views its estimates of this prolXlrtion as being subject to rather wide margins of error. accounts into thrift-institution N OW accounts-or movements of funds between and within thrifts. The result is an under-estimation of the share of new N OWs . coming from savings accounts. Other data sources, however, provide some indication of shifts of funds between banks and thrifts. The Fed finally obtains information from a series of surveys of households conducted by the Survey Research Center at the University of Michigan. These surveys, however, are designed to gain information about a variety of household decisions and attitudes, so that a random sample of households at.large may not be representative of N OW account-holders. Relatio.i 1B' .. These various estimation procedures provide similar results, despite all the statistical and conceptual problems involved. They suggest that time and savings accounts provided between 20 and 25 percent of the N OWs opened in January 1981, and 25 to 30 percent of those opened in later months. Sources of N OW data The Fed obtains its information, first, from surveys of banks and thrift institutions regarding sources of new N OW accounts. However, an institution receiving a new N OW account has no sure way of knowing the source of the funds except for those transferred from another account within the same institution. For example, although a customer opens a N OW account with a ,check drawn on a bank checking account, this does not necessarily mean that that account was the original source of the funds, which may have been shifted from some other type of account only to permit the switch to the other institution. Using the midpoints of these estimated ranges, the Fed now publishes data on "shift-adjusted M-1 B," which represents M-1 B minus the portion of new N OW accounts estimated to have come from non-demand delXlsit sources. Each month, the total increase in N OW accounts (apart from a small "trend" increase) is split into two parts, depending on the source of the original funds. The portion estimated as coming from non-transaction sources is deducted from the total increase in M-l B for that month to yield an estimate of the increase in shift-adjusted M-1 B. The levelof adjusted M-1 B then equals the cumulative sum of these monthly increases. The Fed also obtains information from a statistical analysis of weekly changes in demand deposits and N OW accounts at about 9,000 commercial banks nationwide. This analysis attempts to measure the extent to which increases in N OW accounts are associated with the loss of traditional checking accounts. This approach fails to capture shifts of funds from bank checking This adjusted aggregate rose from $415.6 billion in December 1980to $423.9 billion in April 1981, but then declined to $420.2 billion in July. For the entire December-July period, this represented only a 1.9-percent annual rate of growth, so that adjusted M-l B 2 SBil/lons 445 6% . Growth Money Supply (M-1B) 440 435 3.5% . Growth M-1B 430 425 __ M-1B Adjusted 420 415 410 0 N 1980 0 J F M A M J 1981 Implicationsfor policy tell below the lower bound of the Fed's 1981 target range. By contrast, M-1 B without a shift adjustment increased at a 6.0-percent annual rate between December and July. These two alternative explanations may have different implications for monetary policy in 1982. This reflects the fact that most of the . shift of funds into N OW accounts will probably be completed by the end of 1 981 , whereas high interest rates could continue to induce financial innovations and reduce mqney demand for some time into the future. Many analysts attribute the recent rise in interest rates, deceleration of inflation and reduction of real growth to this slowdown in M-1 B. Nonetheless, nominal GN P has risen substantially faster in 1981 than might have been expected from past relationships of money, income and interest rates. As we argued in the last Weekly Letter, statistical tests using shift-adjusted M-1 B data suggestthat equations explaining this relation were much less successful in 1981 than in earl ier periods. Once the shift into N OWs is complete, this factor will no longer affect the observed monetary growth rate. Even a too high estimate of the share of N OW accounts coming from non-transaction balances would not significantly affect the estimated growthrate of M-1 B once the shift is complete, so that the Fed would have no need to alter previously announced targets for monetary growth in 1 982. On the·other hand, a downward shift in money demand, if continued into 1982, would imply not only less restrictiveness than projected in past targets, but also a continuation of that situation in the future. This would imply a need for downward adjustment of future targets. This phenomenon may perhaps be explained in terms of a falling demand for money, which has permitted the economy to finance a substantial rise in the volume of transactions with only a modest increase in the stock of transaction balances. Last week, we argued that recent financial innovations, such as the growth of money-market mutual funds, might be involved in such a reduction of money demand. At present, there appears to be no rei iable way of judging which of these explanations is the correct one. However, both imply thatthe Fed should lower its targets for 1 981 . Federal Reserve Chairman Volcker recently announced that the Fed planned to aim for the lower bound of its 1981 target during the remai nder of th is year. Such a move wou Id be dictated either by a downward shift in money demand or by a finding of error in the N OW-account adjustment. In the former case, any adjusted M-1 B growth rate is less restrictive than wou Id have been true in the past. In the latter case, the appropriatelyadjusted supply of (M-1 B) money is growing more rapidly than currently estimated. Alternatively, this phenomenon may result from a faulty N OW-shift adjustment-in other words, less N OW-account money has come from non-transaction sources than is currently assumed. As we noted, the Fed's estimate of this proportion is subject to error, as shown by the fact that the Fed bases its adjustment on the midpoint of an estimated range. This suggeststhat the "true" stock of transaction balances may be greater than currently estimated-and that M-1 B may have grown faster this year than the estimated 1.9-percent annual rate. That is, rather than a falling demandfor money, we may be experiencing a higher supply of money than suggested by the official data. However, this argument is weakened by the fact that the error may go in either direction. BrianMotley andJohnP.Judd 3
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